Alcoa's Return To Profitability

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Alcoa (NYSE: AA) is generally seen as a barometer for global manufacturing as airlines, automakers, construction firms and home appliances use its products. Alcoa has seen difficult years, but with the recent better than expected first-quarter results, the company seems to be better positioned for growth.

Alcoa focused purely on aluminum rather than diversifying into other materials like copper or iron ore, which other global mining companies did. This continued focus on only specializing in aluminum products and an oversupply of aluminum resulted in the company facing losses and a decline in its share price. During the recession, Alcoa's market capitalization declined drastically from $47 billion to $5.5 billion. While many companies have seen recovery in its prices, Alcoa has not seen much of recovery.

However, the recent first-quarter result provided a glimpse of hope and a number of positive factors for the company.

Better than expected results

Although revenues declined 2.9% to $5.8 billion versus last year, it reported EPS of $0.13, up 44% versus last year and higher than market expectations of $0.08. Despite weak metal prices, it was able to post strong profitability across all segments. Its net profit was up by more than 50% to $149 million, buoyed by increased demand in aerospace and automotive products.

Further, the company has been able to manage its costs resulting in lower COGS margin, which has improved from 84.9% in 1Q12 to 84.2% in 4Q12 and 83.1% in 1Q13.

Strong profitability across segments

Segment wise, the company experienced growth across all its segments, which were driven by productivity improvements.

Its Engineered Products and Solutions' (EPS) After Tax Operating income (ATOI) increased 23% sequentially from 4Q12 and reported a record EBITDA margin of 20.9%. It quickly kicked out its Global Rolled Products (GRP) segment and expects its ATOI to increase 15%-20% sequentially. In its upstream business, Alcoa's alumina division gained from higher spot prices leading to ATOI increasing sequentially from $41 million to $58 million.

The company has been shifting its business mix focus to value-added products over the last few years. This can be seen from the change in the mix of ATOI - EPS and GRP divisions constituted 71% of the total ATOI in 2012 as compared to 25% in 2003. This favorable trend will help the company to improve its margins and reduce its earnings volatility, which is affected by aluminum price fluctuations.

Improved balance sheet

The company is focused on being free cash flow positive in FY13 and it is taking the necessary steps to accomplish the same. It has been able to reduce its working capital days by 27 days since 1Q09, which equates to approximately $1.8 billion in cash. Similarly since 4Q12 it has been able to reduce its days by 4, which equates to approximately $260 million in cash (Source: company earnings call). Further, the company ended with a strong cash balance of $1.6 billion, which can act as a cushion in case the turnaround takes a longer time.

In December 2012, Moody's placed Alcoa's rating under review for downgrade, which would cost the company's investment grade rating. S&P rates Alcoa at BBB-, its lowest investment-grade rating, with a stable outlook. At the recent earnings call, the company mentioned that it intends to maintain its investment grade rating and this can be seen by its lower Debt/Capital ratio, which has reduced from 42.5% in 2008 to 34.7% in 1Q13. It has mentioned that it intends to maintain this ratio between 30-35%.

Future outlook

The company reiterated its 2013 targets of productivity of $750 million, growth capital of $550 million, sustaining capital of $1 billion, $350 million investment in Saudi, and a Debt/Capital ratio of 30-35%, which will help in meeting its target of positive free cash flow.

It maintained its global aluminum demand growth figure at 7%. It is upbeat about the aerospace market and maintained its 9% to 10% growth rate for 2013. The company boasted about its strong order backlogs for planes with Boeing and Airbus, which it claims may take up to eight years to clear.

In the automotive segment, it expects global growth of 1% to 4% and 7% to 10% growth rate in China. Further, it expects strong growth in the North American market due to the new US Corporate Average Fuel Economy (CAFE) standards, which demand better fuel economy in vehicles and this can be achieved by replacing steel with aluminum to make vehicles lighter.

The company has acknowledged that 50% of its future growth will be driven by China, but at the same time has taken into consideration the recent slowdown in China's economy. This can be seen from its revised 2013 growth forecast in the heavy truck and trailer segment - 12% to 16% versus previous guidance of 12% to 19%.

How are competitors faring?

Comparing to its competitors, Alcoa has performed much better. BHP Billiton (NYSE: BHP), the diversified natural resources company, posted a 14% decline in its 2Q13 revenues citing lower commodity prices and negative foreign exchange fluctuations in major producing nations like Australia and Chile, which resulted in increased costs. It posted a 43% decline in its first half net profit, excluding one off items. The company has undertaken 20 new projects, most of which are expected to enter production by 2015 but expects this growth to be offset by increase in the supply of key commodities due to new or expanded mines, limiting the upside in commodity prices.

Similarly, Aluminum Corporation Of China (NYSE: ACH), which engages in the manufacture and distribution of alumina, and aluminum fabrication products in China and internationally, has its operating profit and net income in the red despite a 6% increase in its revenue in the recent quarter. It posted a worse than expected net loss of RMB8.2 billion ($1.3 billion) for FY12 due to low aluminum prices and rising costs. Its loss was significantly lower as compared to analyst expectations of RMB4.78 billion net loss (Thomson Reuters) and a net profit of RMB237.9 million last year. For 2013, the company has mentioned that it will take the necessary measures to cut costs and expects the start up of new coalmines to boost revenue.

Conclusion

The one factor which attracts me to the company is its Management, which has been able to drive the company to profitability despite a decline in revenues and lower aluminum prices. Furthermore, the company's improved operational performance and drivers for future makes it a good long-term investment at the current price. However, do not expect great returns in the immediate future and be patient as the company moves in tandem with the slowly recovering global economy.


Shas Dey has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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